Need an economist on money creation?

[Eclipse Now]

Hi all,
I've been googling and I just can't seem to find any FREE 'economics 101' podcasts that explain the basics.

I remember reading a depletionist / Malthusian claim that society was addicted to growth and Western economic systems HAD to have growth because the money was being created so fast... otherwise catastrophic inflation would ensue. This was not just crazy hippie stuff, but Phd math's types writing for the CSIRO in Australia. See the essay Debt as the driver of economic growth and excessive consumption; (about 6 page PDF from memory), his argument shorter.

I just watched some videos on money creation over here as well.
The Crash Course | Chris Martenson

Here there's a whole free book on the thing.
Feasta - The Ecology of Money

But I honestly can't make heads or tails of monetary policy which is supposed to combat this stuff. My economics mate says that money creation is neutral to whether or not an economy expands or shrinks, but the guys above seem to imply that money creation DEMANDS a growing economy or 'bad things happen'.

Is there anyone out there that can explain this, to me, a non-economist, in a way I can understand... or at least put me onto a podcast series that might help? (I've tried to read about this stuff at Wikipedia but my eyes go... )

[Nitack]

Your friend is right, currency production and economic growth are not tied together. However, in an economy like the US where the dollar is tied to the economy, the relative strength of the currency unit IS tied to economic growth.

I suppose the points that the individuals in the article were trying to make was this: If you intend to keep your currency stable, and you are printing more currency, then your economy must grow at the same rate you print currency.

There are quite a lot of reasons why you want the relative strength of your currency to remain stable. I won't get into them now, but when you hear stories about wheel barrels of money being needed to buy one loaf of bread, that is the gist of it.

[questor]

Here is some good information...

How does Fed ‘inject’ money into the system? - Answer desk - MSNBC.com

[Eclipse Now]

Originally Posted by Nitack

Your friend is right, currency production and economic growth are not tied together. However, in an economy like the US where the dollar is tied to the economy, the relative strength of the currency unit IS tied to economic growth.

I suppose the points that the individuals in the article were trying to make was this: If you intend to keep your currency stable, and you are printing more currency, then your economy must grow at the same rate you print currency.

There are quite a lot of reasons why you want the relative strength of your currency to remain stable. I won't get into them now, but when you hear stories about wheel barrels of money being needed to buy one loaf of bread, that is the gist of it.

That basically sounds like the argument in the references above —*that it's our money creations system that creates an overall imperative for growth that DEMANDS politicians encourage American and Australian population growth and consumption growth —*or else the wheelbarrows come out!

[Buffy]

I've hesitated to post on this one because you've used such loaded terms in describing the issue that you're after. "Malthusian" is rarely used as anything but an epithet among conservative economists!

Its a complex situation, but rarely is there the "severity" of problems indicated by your adjectives unless any of the policies--and *any* of them can be misused--are not taken in balance but are considered gospel truth. As an example, not raising taxes when they're needed--whether to fund foolish social services or foolish wars of opportunity--is usually a bad idea, and is one of the main sources of the effect that you're hinting at.

Governments can affect "inflationary pressure" in one of two ways:

• Lowering interest rates on government loan instruments--mostly providing liquidity to banks who turn around and loan money based on the fact that they can get higher rates from borrowers--fuels growth because it lowers the cost of borrowing. If this happens, the economy will overheat, increasing demand for labor and resources beyond the supply, thus raising their costs and thus raising inflation and reducing the value of the currency.
• Government spending money that is not supplied either by loans that are actually funded or by increased taxes. This is what is happening in spades in Zimbabwe where the government merely prints money as needed and inflation is running so high that prices change on an hourly basis. No stable government ever does this, BUT borrowing money with abandon can achieve at least part of this "goal" because people lose faith in your currency if your GDP does not grow as fast as you are borrowing funds. The US has managed to get by on borrowing because the economy is so robust and strong, but as that economy has faltered over the last 18 months or so, the value of the dollar to most other currencies--especially the Euro--has dropped dramatically, resulting in at least part of the inflation of oil prices because oil is dollar-denominated.

The fact is that these techniques must be intelligently balanced to maintain a *steady* growth rate in the economy. China is very successful right now, but their growth rate is far higher than average and has resulted in inflationary pressure on the Yuan (which is artificially tied to the dollar, much to the chagrin of most other countries, although to the benefit of the US), but all economists consider this situation to be unsustainable, ultimately resulting in a burst of inflationary effects that will be detrimental to the Chinese economy.

Note however that this is entirely due to a *successful* economy where consumption is actually *suppressed*. Its a wonderful counterexample to the loaded and negative verbiage in your original post.

In the US and Australia, we should be happy that the Chinese are doing these stupid things to their currency because in the short-term its allowing us to avoid pain. But in the long term its going to be ugly for everyone....


I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs,
Buffy

[Eclipse Now]

This argument about money creation is not talking about bad policy, but bad design. They are not talking about bad use of the tools, but that the very tools themselves are broken. As the Financial Sense University says,

A debt-based monetary system has a lifespan-limiting Achilles heel: as debt is created through loan origination, an obligation above and beyond this sum is also created in the form of interest. As a result, there can never be enough money to repay principal and pay interest unless debt is continually expanded. Debt-based monetary systems do not work in reverse, nor can they stand still without a liquidity buffer in the form of savings or a current account surplus.

FSU Editorial: "How Debt Money Goes Broke" by Steven Lachance 12/12/2005

Or as Scientist (not economist) Chris Martenson states:

Consider these data:

* Money supply growth has gone parabolic. It took us from 1620 until 1974 to create the first $1 trillion of US money stock. Every road, factory, bridge, school, factory, and house built, every unit of economic transaction that ever took place over those first 350 years required the creation of $1 trillion in money stock. But it only took 10 months [edit: 2006 data] to create the most recent $1 trillion and I don't recall seeing an entire continent's worth of factories, schools or bridges built during that time. [Edit: that figure is now an astonishing 4.5 months as of March 2008]
* Household debt has doubled in only 6 years. Think about that for a minute.
* Total credit market debt (that's everything) was about $5 trillion in 1975, has increased by $5 trillion in just 2 years, and now stands at over $51 trillion.
* The wealth gap between the super-wealthy and everybody else is widening at a furious pace.

What's going on here? Could it be that the US economy is so robust that it requires monetary & credit growth to double every 6-7 years? Are US households expecting a huge surge in wages to be able to pay off all that debt? Are wealthy people really that much more productive than the rest of us? If not, then what's going on?

The key to understanding this situation was snuck in a few paragraphs ago; every single dollar in circulation is loaned into existence by a bank, with interest.

That little statement contains the entire mystery. If all money in circulation is loaned into existence it means that if every loan were paid back, all our money would disappear. As improbable as that may sound to you, it is precisely correct although some of you are going to consider this proof that I could have saved a lot in tuition costs if I had simply drunk all that beer at home.

But with a little investigation you would readily discover that literally every single dollar in every single bank account can be traced back to a bank loan somewhere. For one person to have money in a bank account requires someone else to owe a similar sized debt to a bank somewhere else.

But if all money is loaned into existence, with interest, how does the interest get paid? Where does the money for that come from?

If you guessed "from additional loans" you are a winner! Said another way, for interest to be paid, the money supply must expand. Which means that next year there's going to be more money in circulation requiring a larger set of loans to pay off a larger set of interest charges and so on, etc., etc., etc. With every passing year the money supply must expand by an amount at least equal to the interest charges due on all the past money that was borrowed (into existence) or else severe stress will show up within our banking system. In other words, our monetary system is a textbook example of a compounding (or exponential) function.

Yeast in a vat of sugar water, lemming populations, and algal blooms are natural examples of exponential functions. Plotted on graph paper they start out slowly, begin to rise more quickly and then, suddenly, the line on the paper goes almost straight up threatening to shoot off the paper and ruin your new desk surface. Fortunately, before this happens, the line always reverses somewhat violently back to the downside. Unfortunately this means that our monetary system has no natural analog upon which we can model a happy ending.

The End of Money | Chris Martenson

[Nitack]

Here is an interesting thought in this topic. Our currency is valued based on the strength of our economy. I don't believe our debt is taken into account though when those valuations are made. The US economy had a GDP of $13.8 Trillion in 2007. The national debt is $9.5 trillion. Shouldn't our debt devalue our currency? After all, it is kind of like having a mortgage on a home. If you owe 90% of the value of your home you should only be calculating 10% of your homes value to determine your net worth.

[modest]

Originally Posted by Nitack

Here is an interesting thought in this topic. Our currency is valued based on the strength of our economy.

Isn't it based on a lot more than that? If the strength of a country's economy stays constant yet the political leadership becomes unstable then currency would loose value (as an example).

Originally Posted by Nitack

I don't believe our debt is taken into account though when those valuations are made.

I would think it is. I don't know exactly how the foreign exchange works, but I'm rather sure it's ultimately people's perception that sets the value and people can take into consideration anything that changes their perception.

Am I way off base here?

~modest

[Eclipse Now]

Wiki on US public debt

Debt held by the public is all federal debt held by states, corporations, individuals, and foreign governments, but does not include intragovernmental debt obligations or debt held for Social Security. Types of securities held by the public include, but are not limited to, Treasury Bills, Notes, Bonds, TIPS, United States Savings Bonds, and State and Local Government Series securities.[1]

As of April 2008, the total U.S. federal debt was approximately $9.5 trillion[2], about $31,600 per capita (that is, per U.S. resident). Of this amount, debt held by the public was roughly $5.3 trillion.[3] If, in addition, unfunded Medicaid, Social Security, Medicare, etc. promises are added, this figure rises to a total of $59.1 trillion.[4] In 2007, the public debt was 36.9 percent of GDP [5], with a total debt of 65.5 percent of GDP.[6] The CIA ranked the total percentage as 26th in the world.[7]

It is important to differentiate between public debt and external debt. The former is the amount owed by the government to its creditors, whether they are nationals or foreigners. The latter is the debt of all sectors of the economy (public and private), owed to foreigners. In the U.S., foreign ownership of the public debt is a significant part of the nation's external debt (see also below). The Bureau of the Public Debt, a division of the United States Department of the Treasury, calculates the amount of money owed by the national government on a daily basis.[8][9][10][11]

The total debt has increased over $500 billion each year since FY 2003, considering both budgeted and non-budgeted spending.[12] The annual US budget deficit declined from $318 billion in 2005 to $162 billion in 2007, but is estimated to increase to $410 billion in 2008.[13] Annual deficits add to the debt. The Congressional Budget Office projects an annual budget surplus by 2012. However, this estimate is based on current law, which assumes sizable tax reductions will expire in 2010.[14] When the U.S. Government has a surplus, it may pay down its outstanding debt by paying back the principal of the outstanding bonds redeemed for payment while not issuing new bonds. The U.S. Government could also purchase its own outstanding securities on the open market if it was searching for a way to use a surplus to reduce outstanding debt that was not due for redemption in a given year.[15][16]

[Buffy]

Financial markets are ruthlessly efficient. No one should underestimate the ability of arbitragers to rapidly snuff out any imbalances in the system. Bubbles do occur like the recent real estate bubble and the previous high tech and tulip bubbles, but even then, the market only allows these to exist because *short term* profits are still available to be exploited.

A country's debt is most certainly taken into account when valuing its currency, but in spite of what you've been told, *debt is not inherently bad*. It can be risky to be sure, but taken in moderation, it is a sure way to increase *wealth* as measured by the growth in output of an economy. *That's* why the dollar does not crash in spite of that mind-bogglingly large amount of debt: people see the American economy as the largest (and therefore unlikely to crash), most consistent in steady and above average growth, having tremendous resources both in physical as well as intellectual property, and thus a "safe" bet to take all that leverage (a fancy euphemism for debt) and turn it into more of the same unstoppable economic juggernaut that its been for the last century.

In other words, for arbitragers, betting *against* the dollar is suicide in the long run.

In the last 4 years though, the Bush administration has been guilty of "talking down the dollar" in an effort to increase trade, but this has angered many of our key international economic (although certainly not *political*) partners who thankfully peg their commodities or currencies to the dollar, like the Petroleum Exporting countries and the Chinese. When the real estate bubble burst at the same time that the oil market went nuts, we got slammed because the government should have long ago started the effort to strengthen the dollar by raising interest rates (if we pay more for those loans, more people buy dollars!), and working to deflate the real estate bubble (also in need of higher interest rates and regulatory pressure).

Ooops!

So to reiterate: you can't call debt "bad": it has an essential role in creating growing economies. But when you start saying royally stupid things like "Deficits don't matter," then all heck breaks loose...

Like they say, "moderation in all things"....

The Middle East, with two-thirds of the world’s oil and lowest cost, is still where the prize ultimately lies,
Buffy